MAS keeps S$ strong as inflation threat stays

Q1 GDP advance estimates disappoint, but economy expected to pick up

[SINGAPORE] Growth in the first quarter was a disappointingly slow 5.1 per cent compared with a year earlier, but economic activity is expected to pick up to a moderate pace for the rest of the year. Inflation, however, remains a sticky problem.

In light of this, the central bank has decided to keep the Singapore dollar appreciating along the same "modest and gradual" path it has stuck to since April 2012 - to ward off persistent wage pressures that will push core inflation higher.

The Monetary Authority of Singapore's (MAS) core inflation measure - which excludes more volatile car and home prices - has risen to an average of 2 per cent year-on-year over the five months from October 2013 to February this year, from 1.6 per cent in the first nine months of 2013.

"This was predominantly due to a more significant pass-through of wages and other business costs," the central bank said. And despite the strengthening currency and subdued price pressures abroad, import prices in Singapore dollars also rose slightly in recent months, it said.

Market economists had accurately predicted both the policy decision, as well as the lower 2014 headline inflation forecast. MAS downgraded this to 1.5-2.5 per cent from an earlier 2-3 per cent given that the large supply of new housing units implies a weaker outlook for imputed rentals and car prices should "add negligibly" to inflation.

But this lower headline inflation forecast remained "subservient" to elevated core inflation when it came to the policy decision, as OCBC currency strategist Emmanuel Ng put it.

Indeed, MAS warned that though imported inflation will be benign, domestic costs - particularly wage pressures from the tight labour market - could mean that sequential core price increases will be slightly higher than the historical average this year.

"Firms are expected to continue to pass on accumulated costs, which could lead to broad-based price increases across the economy," MAS said.

The policy trade-offs of the central bank's decision this round were fewer, as the economy is expected to trot out a modest pace of recovery, notwithstanding the uncertain start in Q1.

Advance estimates released by the Ministry of Trade and Industry (MTI) show that Q1 GDP growth came in weaker than the market had expected, moderating in both year-on-year and sequential terms.

The economy expanded 5.1 per cent in Q1 compared to a year ago - lower than Q4's 5.5 per cent - as a slowdown in the services sector dragged down gains from the manufacturing sector.

Overall GDP fell short of the consensus forecast. The 18 private sector economists polled by Bloomberg had a median year-on-year growth forecast of 5.4 per cent.

Growth in the services sector eased to 4.7 per cent compared with a year ago, lower than the 5.9 per cent growth seen in Q4. This was due to slower expansion in the wholesale & retail trade, and finance & insurance sectors.

Despite the slip, Mizuho economist Vishnu Varathan believes that the services sector will remain a key pillar of growth this year. And DBS's Irvin Seah expects Q1 GDP to be adjusted upwards in May, "given the current conservative estimate in terms of (services') growth momentum".

The manufacturing and construction sectors, however, performed better. Manufacturing grew at a faster pace of 8 per cent in Q1, boosted by higher biomedical and chemicals output. The latter benefited from public construction projects, and grew 6.5 per cent year-on-year.

Despite the weaker-than-expected showing in overall Q1 GDP, both the government and private sector economists remain sanguine about growth prospects this year.

Notwithstanding Q1's weaker performance, MAS said that "the level of economic activity should stay on a broad upward trajectory for the rest of the year".

Economists Michael Wan of Credit Suisse and Francis Tan of UOB agree. They say that Singapore's trade-related sectors should expand as the global economy - and particularly the US and Europe - stages a stronger recovery.

Still, the MAS warned that "overall growth will be capped by supply-side constraints, particularly in the labour market".

The government has maintained its 2014 growth forecast of 2-4 per cent, even as it warned that "the growth profile could be uneven". Economists' projections are largely at or beyond the upper end of this band, with growth forecasts ranging from 3.5-4.3 per cent.

While the next policy review is not due till October, economists from ANZ and Credit Suisse believe the hurdle for easing monetary policy is "still extremely high". Mr Wan noted that the tightness in the labour market showed no signs of easing, given that a fresh round of foreign manpower restrictions are due in July, with more to come in 2015 and 2016.

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